China’s tightrope walk

The latest GDP data from China show the world’s second-largest economy seemingly in good health. Third-quarter growth was 6.7 per cent, reflecting the government’s continued pump priming by way of increased spending, and a robust property market. That the headline number came in exactly at the same reading as the previous two quarters also signals a level of almost unnatural stability in the economy’s performance as expansion has hovered around 7 per cent or very close to it for the last nine quarters, ensuring that there has been no hard landing as the key global growth engine slows. 
Earlier this decade the Chinese government began a ‘re-balancing’ of the economy by shifting the focus away from a production and export-led model to an increasingly domestic consumption and services reliant one; it has had some success in this with consumption contributing 71 per cent of GDP growth in the first three quarters of 2016. Still, the high level of government spending and the mounting debt - core debt as a percentage of GDP exceeded 250 per cent in the first quarter according to data compiled by the Bank for International Settlements — are causes for concern. 
With the state leading investment in infrastructure as a means to stabilize growth, public spending climbed 12.5 per cent in the nine-month period, widening the nation’s fiscal deficit. But it is the pace and size of the overall credit expansion that have set alarm bells ringing, including at the International Monetary Fund.

In a working paper titled ‘Resolving China’s Corporate Debt Problem’, the IMF has cited international experiences with similar-sized credit booms to caution that China increasingly risks facing slower growth or a “disruptive adjustment” unless it acts quickly. With both scenarios fraught with danger, Chinese planners will be cognizant of the social costs a sudden, sharper slowdown can extract. Japan’s economic doldrums since its ‘lost decade’ at the end of the last century is a primer of what could ensue from such an economic slowing. That leaves Beijing with the unenviable choice of determining the contours of the ‘adjustment’ that would need to be implemented post-haste to address the precipitous debt overhang. 
The authors of the IMF paper advocate a comprehensive strategy and note: “Risks appear high but manageable if the problem is addressed promptly, but the window is closing quickly.” Their prescription includes the political will to identify companies in financial distress, unmindful of whether they are state-owned or private, and standards to get lenders to acknowledge the true levels of bad loans. Steering a large ship through a course-changing turn with precision is never easy, and ensuring that the $10-trillion economy stays on its feet while re-balancing could prove a challenge.


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